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Currency Momentum, Carry Trade, and Market Illiquidity

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Currency Momentum, Carry Trade, and Market Illiquidity” by Vitaly Orlov investigates the impact of equity market illiquidity on the excess returns of currency momentum and carry trade strategies.

This empirical study explores the association between market illiquidity and the performance of these strategies, revealing that equity market illiquidity significantly influences the payoffs of currency momentum strategies.

Interestingly, the study found that months of high equity market illiquidity are linked to low returns on currency momentum, notably affecting the evolution of this strategy. However, the effect of illiquidity on carry trade returns is not evident.

Notably, the recent decade has witnessed a positive predictive relationship between illiquidity and currency momentum strategy payoffs, a finding that is economically significant and robust to various checks.

The study’s results suggest that illiquidity predictions approximate one-third of the average monthly profits, offering compelling insights into the nuanced interplay between market illiquidity and currency strategies.

Abstract Of Paper

This study empirically examines the effect of equity market illiquidity on the excess returns of currency momentum and carry trade strategies. Results show that equity market illiquidity explains the evolution of currency momentum strategy payoffs, but not carry trade. Returns on currency momentum are low following months of high equity market illiquidity. However, in the recent decade, illiquidity positively predicts the associated payoffs. The findings withstand various robustness checks and are economically significant, approximating in value to one-third of average monthly profits.

Original paper – Download PDF

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Author

Vitaly Orlov
University of St. Gallen – School of Finance; Swiss Finance Institute

Conclusion

In conclusion, the research paper “Currency Momentum, Carry Trade, and Market Illiquidity” by Vitaly Orlov provides valuable empirical evidence on the influence of equity market illiquidity on currency momentum and carry trade strategies.

The study’s findings illuminate the significant impact of market illiquidity on the evolution of currency momentum strategy payoffs, with little effect observed on the carry trade strategy.

Notably, the recent decade has seen illiquidity positively predict currency momentum strategy payoffs, emphasizing the evolving dynamics of this relationship.

The robustness and economic significance of these findings, approximating one-third of average monthly profits, underscore the consequential nature of market illiquidity in shaping currency strategy payoffs.

This research offers implications for investors and policymakers seeking to navigate these strategies amid varying market conditions.

Related Reading:

Two Centuries of Multi-Asset Momentum (Equities, Bonds, Currencies, Commodities, Sectors and Stocks)

Global Political Risk and Currency Momentum

FAQ

Q1: What is the main focus of the research paper “Currency Momentum, Carry Trade, and Market Illiquidity” by Vitaly Orlov?

A1: The main focus of the research paper is to empirically investigate the impact of equity market illiquidity on the excess returns of currency momentum and carry trade strategies. The study explores the association between market illiquidity and the performance of these currency strategies, shedding light on how equity market illiquidity influences their payoffs.

Q2: What does the study reveal about the association between market illiquidity and currency momentum strategy payoffs?

A2: The study reveals that equity market illiquidity significantly explains the evolution of currency momentum strategy payoffs. It specifically finds that months of high equity market illiquidity are associated with low returns on currency momentum. Interestingly, the recent decade has seen a positive predictive relationship between illiquidity and currency momentum strategy payoffs.

Q3: How does market illiquidity affect the carry trade strategy returns, according to the findings?

A3: The study finds that the effect of illiquidity on carry trade returns is not evident. While equity market illiquidity plays a significant role in shaping currency momentum strategy payoffs, its impact on carry trade returns is not observed, suggesting a different relationship between illiquidity and the two currency strategies.

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